Europe May Finally Be Compelling for Investments | The Smarter Investor | US News – U.S News & World Report Money

European stocks underperformed relative to U.S. stocks for much of the past decade. Europe’s tepid economic growth, stagnant productivity and often-questionable economic policy choices were among the factors contributing to investor frustration.

That said, investors should consider revisiting their outlook for Europe, as the spending package has been approved by the European Union and Europe has had relative success in reopening amid the global health crisis.

The European Recovery Plan

The European Union’s 1.8 trillion-euro budget ($2.2 trillion) includes 750 billion ($882 billion) euros that are earmarked to help member states rebound from the economic damage associated with the pandemic.

The recovery plan provides grants and loans to aid the EU countries hit hardest by the pandemic, including Italy and Spain. The most noteworthy aspect of the plan is that it is funded by the issuance of hundreds of billions of euros in bonds that will be the obligations of the EU rather than member states. The recovery plan, which still must be approved by the parliaments of the 27 member states, is a symbolic leap toward fiscal union.

In addition to the promise of fiscal support, monetary policy remains loose in Europe with the European Central Bank expanding its bond-buying efforts to provide additional liquidity to struggling Southern Europe.

Europe’s Economic Growth

Mobility and economic activity measures in Europe offer encouraging signs that economic growth will rebound from the severely depressed levels of March and April. Europe’s stocks are more cyclical than the U.S. market, with industrial, material and consumer discretionary stocks representing high percentages of European stock indexes. European markets are also export-driven, so a sustained economic recovery in China could also be a positive catalyst.

European Stocks Are Trading at a Discount

European equities typically trade at a lower valuation multiple than U.S. stocks, but that discount is greater than the historical average. A backdrop of improving economic growth in Europe and continued containment of the virus could provide support for a narrowing valuation discount. European bank stocks bear watching, as banks sold off sharply in response to threats to private sector balance sheets from the deepest recession in nearly a century. Investors expect a rapid rise in nonperforming loans (NPLs), but NPLs may not expand by as much as anticipated given substantial support by global monetary and fiscal authorities.

The U.S. Dollar Due for a Fall

The U.S. dollar has weakened, perhaps marking the end of a long period of dollar dominance. The euro is widely considered to be undervalued in terms of purchasing power parity relative to the dollar. In addition, the steep reduction in U.S. rates narrows the interest rate advantage relative to euro-denominated assets, while dynamics with the balance of payments are increasingly bearish for the U.S. dollar. Mutualized debt could be another positive catalyst for the euro and could lead to Europe becoming a more desirable destination for investors seeking a “safe” bond alternative to U.S. Treasury debt.

Investing Internationally Provides Diversification

Over multidecade periods, portfolios with international exposure of at least 20% offered similar returns and lower volatility than U.S. equities. In addition, the U.S. represents about 15% of global gross domestic product and less than half of global market capitalization. U.S. stocks have been dominant in the past decade. The last year in which non-U.S. stock indexes beat the S&P 500 was 2017. But just because U.S. indexes showed greater returns than international indexes over the past decade does not mean all the best stocks are in the U.S. In fact, on a company-by-company basis, it is the opposite: The stocks with the best annual returns have been overwhelmingly located in non-U.S. markets, with many of those strong performing companies domiciled in Europe.

As is the case throughout the world, public and economic health will remain tightly interconnected for the foreseeable future. Consequently, there may be a significant divergence of performance among European stocks. European stocks with strong balance sheets, cash flows and sustainable business models may offer the greatest stability in an uncertain environment. There are undoubtedly some opportunities among the beaten-down segments of the market, but it is important to assess which companies will have the staying power (or get the government support) necessary to “get to the other side” of the pandemic.

The symbolic leap toward fiscal integration provides needed capital to the hardest-hit countries in the EU and boosts the spirits of long-suffering investors in European stocks. Investors should take note of the changing landscape in Europe and look for opportunities to capitalize.

Disclosures: Registration with the SEC should not be construed as an endorsement or an indicator of investment skill, acumen or experience. Investments in securities are not insured, protected or guaranteed and may result in loss of income and/or principal. Unless stated otherwise, any mention of specific securities or investments is for hypothetical and illustrative purposes only. Advisor’s clients may or may not hold the securities discussed in their portfolios. The advisor makes no representations that any of the securities discussed have been or will be profitable.

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